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Posts Tagged ‘SIP’

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Some days back, in a discussion with a friend of mine, we once again ended up discussing whether mutual funds and in specific whether Equity mutual funds, play any role in goal based investing. Can an investor gather any sizeable corpus by systematic investing?

After a lot of discussion and arguements both for and against from her side and mine, I presented to my friend the below example.

Suppose you were to invest Rs. 1000 in a SIP in a equity mutual fund from January 1995 till 30 Sep 2013, and invest regularly each month. Simultaneously one could also invest in the Sensex a similar SIP of Rs. 1000 for the same time duration. Once could argue that the returns would depend on the type of mutual fund scheme chosen. So as to avoid being partial to any particular style or scheme, we took the SIP and simulated it over many different types of schemes such as a large cap scheme, a mid cap scheme, a value category scheme and a hybrid equity oriented (balanced) scheme and the Sensex.

When we tried to map the values of these SIP investments, the results were as you can see in the graph below.

SIP_Analysis

Scheme Type Value  of Rs 2.25 Lakhs Returns (xirr)
A Equity Large Cap Scheme Rs. 24.3 Lakhs 21.7%
B Equity Flexi Cap Scheme Rs. 23.5 Lakhs 21.5%
C Equity Mid Cap Scheme Rs. 22.4 Lakhs 21.1%
D Hybrid Equity Oriented Scheme Rs. 20.1 Lakhs 20.2%
E S&P BSE Sensex Rs. 7.7 Lakhs 11.9%
F NSE CNX Nifty Rs. 7.6 Lakhs 11.7%

In the simple example above, we figure that an investor by investing Rs. 2.25 Lakhs over a time period of about 19 years, has been able to grow his money from a small Rs. 2.25 Lakhs to a sizeable corpus of Rs. 24 lakhs (in case of scheme A). She has been able to get phenomenal returns in the range of 20-21% each year, depending on the scheme selected (A to D).

Even if the investor had invested in either the BSE Sensex or the CNX Nifty (Scheme E or F), she would have made returns in the range of 11% each year.

This brings us back to the moot question. Can we use SIPs for goal based investing. The answer as we can gather from the above analysis is a big Yes.

For all of us who are looking at investing simple small amounts each month, without burdening ourselves with huge commitments, can look at this example as an easy solution to garnering corpuses for long term goals. Of course, there are a few caveats:-

– this example assumes systematic investing of Rs 1000 each month, without fail for the last approx. 19 years, which means riding through both bullish and bearish phases of equities and giving equity investments the time they deserve

– this example also assumes no redemptions have been made from each SIP investment, especially important during bearish phases where most of us contemplate stopping our SIPs

– past performance is not indicative of the future, but history does teach us some important lessons.

So keep investing towards your goals and keep the faith !

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SYSTEMATIC INVEST-MENT Plans (SIPs) have become extremely popular over the last few years to invest in stock markets. They allow investors to take a gradual exposure to stocks by investing small amounts every month in mutual funds or in stocks.

One of the biggest advantages of investing in an SIP is the benefit of ‘rupee cost averaging’. Essentially, what rupee cost averaging achieves is that a fixed amount of money is invest-ed each month on a fixed date, irrespective of the market level.

When the markets are at a higher level, less units will be purchased with the same amount, while when markets are at a lower level, the number of units purchased will be higher. Over a period of time, an average price is achieved which is a result of purchases at the lower and higher prices at multiple levels of the stock market.

With the outlook for the stock markets having turned negative over the last few weeks, driven by both domestic and international factors, people have started wondering if they should invest or suspend the investment plan for a while.

In our view, if you stop our investment, it will defeat the very purpose of using the SIP strategy. With the markets in the bearish trend, this is actually a good time for you to invest in SIP as you can continue to get a higher number of units at lower prices over the next few months.

Mr Warren Buffet, arguably the most successful investor of our times in his letter to his shareholders in 1997 put this very aptly in the form of a short quiz: “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?” These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers”, they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

We ran a simulation for investors who invest in SIPs during the period of Jan 2008 to June 2011 when the markets peaked, subsequently crashed and then recovered significantly. We found that even though the BSE Sensex is currently down eight per cent from those levels, SIP investors in a cross-section of funds would have returns ranging from 12 per cent to 25 per cent per annum assuming that they continued with their SIPs through this period of three and a half years ago.

Considering this empirical data, we strongly recommend that investors use this opportunity to enhance their SIPs, rather than stop or lower them. In fact, we would recommend that wealthy investors who have traditionally stayed away from SIP strategies and actively try to time the market, should also use this opportunity to do SIPs or systematic transfer plans.

This article was written by Vishal Dhawan, CFPCM and appeared in the Asian Age on 25th July 2011 .

 

 

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Answers to an inquisitive audience on Sustainable Wealth Creation forum hosted by CNBC

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